WiseTech Global (ASX:WTC) shares have had a really impressive month, gaining 31%, after some slippage. But that gain wasn't enough to make shareholders whole, as the share price is still down 7.6% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does WiseTech Global's P/E Ratio Compare To Its Peers?
WiseTech Global's P/E of 71.35 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (37.7) for companies in the software industry is lower than WiseTech Global's P/E.
Its relatively high P/E ratio indicates that WiseTech Global shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, WiseTech Global grew EPS like Taylor Swift grew her fan base back in 2010; the 78% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 47% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does WiseTech Global's Debt Impact Its P/E Ratio?
Since WiseTech Global holds net cash of AU$233m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On WiseTech Global's P/E Ratio
WiseTech Global's P/E is 71.3 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What is very clear is that the market has become significantly more optimistic about WiseTech Global over the last month, with the P/E ratio rising from 54.5 back then to 71.3 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.